Members of Congress and the administration have finally laid out their opening bids for tax reform, but neither the House nor Senate version of the tax bill has been met with particular enthusiasm. This is a shame, because our tax code is incredibly inefficient and both bills actually do make some major improvements.
The bills share one fatal flaw, however. They each make the mistake of conflating tax reform with tax cuts. Both the House and Senate bills, in addition to making much needed changes to the tax code, will cost roughly $1.5 trillion over 10 years.
It is true that the tax cuts included in each piece of legislation will help offset that cost, but even using the most optimistic assumptions available, the costs will still be substantial. The Tax Foundation, for example, found that even accounting for economic growth and ignoring the effects of a higher deficit, the House plan would still cost almost $1 trillion.
This matters for two very important reasons. First, we’re not in a position to increase the national debt today. Our current debt is as high as it’s been since the late 1940s, when we were still coping with war debts. What’s more, it’s growing at an incredible rate, having essentially doubled since the Great Recession, and shows no signs of slowing.
The Congressional Budget Office estimates that even if the Trump administration were to make no changes from current law, mandatory spending will make up more than 90 cents of every federal tax dollar by the end of its first term. That means that by 2020 we’ll be borrowing to pay for almost everything else in the budget, from aircraft carriers to Zion National Park. This is unsustainable, and until we get a better handle on controlling spending growth we can’t afford to be losing revenue.
Second, not every American will see their tax bill go down as part of tax reform. This is not necessarily a bad thing from an economic perspective. Tax reform always results in winners and losers. From a political perspective though, the losers need to be convinced that they’re losing for a good reason. Under the two bills proposed so far, this is proving a tough sell.
Under both pieces of legislation an overwhelming majority of Americans will see their taxes go down. For the minority of households who will see their taxes go up, mostly among those making $200,000 to $500,000 per year, taxpayers may not necessarily be averse to a small tax increase if they feel it’s for a worthwhile cause.
Raise my taxes to pay down the national debt or to rebuild roads and bridges? I’m not happy about it, but OK.
Raise my taxes to cut other people’s taxes and raise the national debt? Not a chance.
This is a huge political problem for Republicans, as the affected taxpayers traditionally lean conservative. The Republican Party is supposed to be the party of fiscal responsibility, and to many key voters these two pieces of legislation look awfully irresponsible.
Where do we go from here? I see three possible outcomes.
First, let’s assume that Congress does pass a bill that looks relatively close to what has been proposed so far. That would be a huge legislative win for Republicans, but at the expense of some core Republican constituents. One can argue that this would provide some much needed help in 2018, but it could also really hurt in 2020, especially if Congress needs to go back and make fixes before then to clean up rising deficits.
Second, let’s assume that Congress fails to pass any tax legislation. This would be a worst-case scenario for Republicans in 2018, but may allow them to recover in time for the 2020 election. Either way, America ends up continuing on with a terribly inefficient tax code at the expense of our economy.
Lastly, let’s assume for just a minute that there is a compromise. This may seem far-fetched in today’s Washington, but it’s the only hope of getting the bill Americans really need. The biggest flaw in the two plans being considered today is the cost.
Would certain elements of Congress be willing to compromise to bring that cost down? Cutting the corporate rate to 25 percent instead of 20 percent perhaps? Keeping rates for high-income earners where they are in order to pay for larger child and family credits for low- and middle-income taxpayers?
The best thing going for us is that tax reform is not necessarily a binary choice like health-care reform. Tax reform exists on a broad spectrum in which compromise is not only possible, but necessary. This should give Americans hope that meaningful reform is still a possibility.
Dan White is a director of economic research at Moody’s Analytics in West Chester and serves as an adjunct professor of economics at Villanova University. email@example.com @DanWhiteEcon